Model for Small Business Funding Reform

“Crowdfunding” has taken off on the non-profit sector as a way for people to collect funding from several small sources on the condition that the money will be paid back, and now a new website called Startupexemption.com is exploring how to bring this power to for-profit companies. The problem now is that Securities and Exchange Commission rules for business funding place certain requirements on the process that do not allow for crowdfunding in the for-profit business community, but the entrepreneurs behind Startupexemption.com have been asked to testify before Congress regarding small-business funding reform. Eliminating SEC red tape for small businesses is an issue embraced on the both sides of the aisle, and experts believe crowdfunding could play a large role in the future of small business. For more on this continue reading the following article from TheStreet.

Asking people for money is never easy, but it's a crucial step in building a business. In the current economic climate, with bank loans hard to come by, hitting up family and friends for cash is one of the few ways would-be entrepreneurs can get a company off the ground.

What if there was another way? Creative thinkers in the nonprofit world have come up with a game-changing model for increasing donations: crowdfunding. Combining the far-reaching power of the Internet with an accessible, low-entry-cost attitude, crowdfunding sites have shown that a lot of small contributions can add up to a major impact.

One of the most successful crowdfunding sites, Kiva.org, facilitates microfinance lending around the world. The site profiles the people and projects looking for funding, whether it's a shopkeeper looking to expand in Honduras or an Iraqi widow who wants to buy an industrial sewing machine for her growing tailoring business. Donors can contribute as little as $25, with the expectation that they will be paid back (Kiva borrowers as a whole have a 98% repayment rate).

Other sites use the same model for charitable donations. Donorschoose.org allows teachers throughout the U.S. to post specific requests for classroom materials; donors can contribute any amount, then get photos of class using the supplies once the funding goal is met. At Kickstarter.com, artists make pitches for their projects, which range from independent films to board games.

Entrepreneur Sherwood Neiss wondered: If Kiva is helping budding entrepreneurs in the developing world, why can't a similar model work at home? Neiss, who co-founded and then sold the company FLAVORx, which developed flavorings for children's medicine, was looking for a challenge. He had some promising ideas, such as developing a wind farm in Puerto Rico, but couldn't get funding. Why not solicit investors in the same way as Kiva and Donors Choose?

Because raising money from many small investors on behalf of a for-profit business is against the law. Any company that plans to offer returns to investors has to register with the SEC, a process that requires lawyers and tens of thousands of dollars in fees. Even after the filings are complete, new companies are limited to only 35 "unsophisticated" investors and face tight restrictions on raising funds outside their state. That means an entrepreneur is dependent on a few large investors rather than many small ones -- a much larger hurdle to jump.

"This isn't rocket science," Neiss says. "Everyone's looking at small businesses to create jobs, but there's no capital flowing. Yet these donation sites are working." Many Americans simply aren't aware of the restrictions put on startup funding. "When I tell people about what I'm advancing, their first question is, 'What do you mean, I can't use my own money how I want? That's not the American way!'"

Neiss, along with fellow California-based entrepreneurs and friends Jason Best and Zak Cassady Dorion, began talking about how those 1930s-era SEC regulations needed to be updated for modern business. From those casual conversations came a growing determination to act, and the three men convened a startup weekend to hash out the idea.

"The goal of the weekend was to launch this movement," Neiss says. "It was a real debate, but we knew by the end we had to come up with a minimally viable option." They ended the weekend with a detailed, specific framework for how the SEC regulations should be changed, while still protecting investors against risk. They created a website, Startupexemption.com, to explain their mission and post their proposed changes (which had been tweaked after input from securities lawyers, economics professors and other experts).

Now, less than a year later, Neiss and his friends have seen their idea come tantalizingly close to reality. There's been great interest in Washington, D.C., and Neiss was recently invited to testify before Congress. Easing the SEC regulations on business funding is one of the rare initiatives that appeal to Democrats and Republicans, and President Barack Obama's recent jobs act cited the Startup Exemption framework almost word for word. Proposed legislation has been written, and once it has Congressional co-signers the SEC rules could be changed by the end of the year.

Will crowdsourcing work for every business? Of course not. But Americans are more aware than ever that their buying habits directly affect their local economy. Given the chance to support a promising business, and spurred by the hope of earning a return on that investment, small-scale investors could have a real impact on job creation. As a grassroots movement, Startup Exemption is fueled by that promise. "We have a passion for doing something that can help everyone," Neiss says. "This is what entrepreneurs live for, the high of making things happen."